Seminar on Trading Strategies, Fundamental Analysis

Universidad de la Sabana
Formulas for the Exam (these formulas will be provided to students during the exam)
Prof. Urbi Garay
March, 2019

Present value of dividends (these formulas can also be used for FCFE and FCFF):
Zero growth:
Div1 Div 2 Div 3
P0    
(1  r ) 1
(1  r ) 2
(1  r ) 3
 
Div
P0 
r
Constant growth:
Div1
P0 
rg

Differential growth (to avoid mistakes, it is recommended that students apply this formula logically instead of
just replacing each of the numbers):

 Div N 1 
 
DIV1  (1  g 1 )   r  g 2 
T
P 1  
r  g1  (1  r ) T  (1  r ) N

g (sustainable growth rate) = Retention ratio × Return on equity, or RR x ROE

r (also known as k, the required return by investors) can be estimated as follows:
Div1
1) r   g (estimated from the constant dividend growth model)
P0

2) Estimated from the CAPM: E(r) = Rf + Bi [E(RM) – Rf]

Degree of operating leverage (DOL) = % Change in profits / % Change in sales

FCFE (Free cash flow to equity) = Net Income + Depreciation Expense - Capital spending (or change in gross
PPE) - Change in Working Capital [or change in current assets (accounts receivable and inventory) minus change
in current liabilities (consider only accounts payable)] - Principal Debt Repayments + New Debt Issues
FCFE1
Constant growth formula : Value 
k  g FCFE

Value of the firm’s equity per share (from FCFE) =

Value of the firm’s equity (from FCFE) / total number of common shares
FCFF (Free cash flow to the firm) = EBIT (1-Tax Rate) + Depreciation Expense
- Capital Spending (or change in gross PPE) - Change in Working Capital [or change in current assets (accounts
receivable and inventory) minus current liabilities (accounts payable)] - Change in other assets
WACC (weighted average cost of capital) = WE k + WD i
WE = the proportion of equity in total capital
k = the after-tax cost of equity (from the SML/CAPM)
WD = the proportion of debt in total capital
i = the after-tax cost of debt
Enterprise value = Market value of equity (market capitalization) + Market value of debt, less any cash

FCFF1
Constant growth formula : Value of the firm 
kWACC  g FCFF

Value of the firm’s equity (from FCFF) = Present value of FCFF – Value of debt
Value of the firm’s equity per share =
Value of the firm’s equity (from FCFF) / total number of common shares

Using the P/E to estimate a stock price:

Price = Sales x Profit margin x P/E
Where: Profit margin = Net income / Sales
Also,
Price = Earnings per share (EPS) x P/E
Note: Both E and EPS stand for earnings per share